Investment Overview for 2006-07
At the global level, China’s mainland sharemarkets were the standout performers in 2007 after quadrupling in value over the past two years. In May 2007, India became the third emerging stock market after China and Russia to surpass $1 trillion in value. China’s growth rate is forecast steady at 10.4% this year and next, from 10.7%. India’s growth is forecast to slow to 8.5% next year, from 9% and Russia’s, similarly, to 6.5%. These emerging economies are having a fundamental impact on the world economy given their extraordinary growth and demand for commodities.
MilitarySuper has been one of the first Australian superannuation funds to invest in the emerging Chinese economy. Although it is early days, the results to date have been very encouraging with our first private equity investment achieving strong positive returns in its first year. This is a result not normally expected in the world of private equity. The MSB Board is pursuing other opportunities through relationships forged with key Chinese Government agencies.
However, underpinning these positives is a cautionary undertone that volatility will persist in equity markets and double digit returns from listed equities are not sustainable over the long-term. That is why MilitarySuper’s investment strategy places less reliance on listed equities to achieve long-term sustainable returns in most market conditions.
Despite the Fund’s lower exposure to listed equities than many of its peers, MilitarySuper has achieved strong returns for the fourth consecutive year since the implementation of its revised investment strategy.
Importantly, since the implementation of its revised investment strategy the Fund has achieved returns averaging 14.9% (net) for the Growth option and 16.9% (net) for the High Growth option in each of the subsequent years.
Returns from listed equity markets
International equities
Investments in international markets carry two distinct forms of risk. One relates to the impact of local market forces on the underlying value of the investment in the local currency in which it is denominated. The second relates to the value of that same investment when viewed in Australian dollar terms due to movements in international currency exchange rates.
To manage the second of these risks, MilitarySuper employs a 100% hedge over the Fund’s exposure to overseas currencies whereby exposure is adjusted regularly through use of currency forwards. This is done in order to minimise losses when the overseas currency loses value (against the AUD) but also allows the Fund to participate in growth when the overseas currency increases in value.
With a dynamic approach, the hedges can and do move significantly away from the benchmark when an appropriate opportunity is there, assuming it can be prudently exploited. Both hedged and unhedged active strategies have shown the capacity to provide a very good degree of downside protection when the Australian dollar is strong and upside capture when the dollar is weak.
On a fully hedged basis the contribution made by the International Equities asset class allow the portfolio to the gross overall Fund performance was an impressive 23.1% for the year compared to an unhedged return of 8.1%.
Australian equities
As with the International Equities portfolio, MilitarySuper has appointed a range of investment managers in the domestic equities sector with demonstrated skills in adding value through stock selection and active management over a concentrated portfolio of stocks. The manager configuration is comprised of a large number of smaller (in terms of assets under management) managers. Several of these are classified as broad market managers, two are long-biased managers and one specialises in small companies.
Their combined management styles are best suited to periods of falling markets and, whilst the gross return of 28.4% achieved for the year was impressive, it was nonetheless 0.8% below the strong returns of 29.2% achieved by the benchmark S&P/ASX 300 Accumulation Index.
Going forward, the Fund believes that these managers will provide increased opportunity to achieve above benchmark returns reflecting the concentrated and index insensitive approach of the individual managers.
Property
In the finance industry, property usually refers to real estate, including land and buildings that can be bought, sold or leased. A Property Trust is a collective investment vehicle which owns a portfolio of real property, thus providing for a wider spread of ownership.
Many property investments have fixed income streams attached to them ensuring a minimum level of return on the investment, unaffected by movements in investment markets. Accordingly, many property investments will exhibit characteristics similar to traditional defensive assets.
Consistent with its strategy of moving away from reliance on listed markets, during 2006-07 the Fund replaced its exposure to property through listed equity trusts with direct exposure via co-investment opportunities both domestically and internationally. These opportunities enable the Fund to take both equity and debt positions in both property development projects and in established property investments. The equity exposure provides opportunity for high rates of return via capital growth, whilst the debt exposure provides access to long-term sustainable cash flows.
Most of the investments held in the property sector are still in the initial investment growth phase and as such good returns are not expected in the short-term. Therefore the Fund is yet to see the benefits of capital appreciation from these investments and the contribution to overall gross Fund performance for the year was 5.1%.
Infrastructure
Infrastructure involves investment in the development of facilities and services required by the community and for production, such as government buildings, airports, toll roads, power, telecommunications and water supply.
Investment in infrastructure may take the form of investments in start-up projects or in established facilities. Investments in the latter provide access to strong cashflows and potential for future capital growth. Therefore, this form of investment can display similar defensive characteristics to more traditional defensive assets.
The Fund’s existing infrastructure investments have continued to post impressive results; with the best performing Fund for the year again being the investment in the ANZ Energy Infrastructure Fund which returned 36.8% for the year.
Importantly, with infrastructure investment MilitarySuper has access to co-investment opportunities through its established relationships. These co-investment opportunities will enable the Fund to participate in investment projects not normally available to superannuation schemes, offering access to superior long-term capital growth and stable cashflows. At the time of preparation of this report, the Board was finalising negotiations for a co-investment in Wind Farm technology in the USA. This is consistent with the Board’s intention to continue to evaluate both the investment risks and opportunities afforded by global warming and noting global concerns about carbon emissions and the push towards greater use of renewable energy sources.
This sector produced an overall return of 8.1% (gross) for the year.
Private equity
Private equity is generally described as acquiring an equity interest in an unlisted company or enterprise. This type of investment usually refers to investments in relatively small, unlisted companies which have an established track record in their field of business and which require new sources of funding to finance their expansion. This contrasts with venture capital, which in Australian usage tends to refer to investments in start-up companies only.
Private equity investments offer extremely attractive long-term risk-adjusted return characteristics consistent with the absolute return focus of the Fund’s new investment strategy. This type of investment has return characteristics which are of a growth nature.
Private equity is a long-term investment and does not generally show a return in the early years of the investment because of initial set-up and management costs. The investment gains usually come in later years as the underlying portfolio of companies mature and increase in value. This timing is known as the J-curve effect.
The Fund made its first investment in Private Equity in 2000 and has since made regular additional commitments to this asset sector, both domestically and internationally.
As the initial investments are maturing, MilitarySuper is now starting to see the benefits from this asset class, with significant returns starting to flow back to the Fund. Indeed at the portfolio level Private Equity investments provided a return of 15.4% for the year; with the Fund’s domestic private equity investments in particular continuing to provide strong returns. MilitarySuper’s best performing Manager for the year was our Australian Private Equity Manager - Pacific Equity Partners with a remarkable 108% return for the year. This was the result of a strong IPO through their investment in Emeco.
Uncorrelated alpha
This asset class involves investment in a range of assets whose performance is not directly correlated to the performance of listed equity markets. This type of investment includes investments in real assets (for example, timberland) or in hedge funds which can act as a powerful diversification tool and a generator of strong returns.
Such investments also display characteristics which are of a growth nature but with returns which are not directly correlated with performance in listed markets.
This sector displays defensive characteristics and is generally expected to perform best in falling markets. Given the strength of listed equity markets the return achieved from this asset class was 3.9% (gross) for the year.